Maybe the Renminbi Won't Rule the World After All

Here's a neat riposte from Eswar Prasad and Lei Ye to the idea that the RMB will surpass the dollar as the world's most important currency over the next decade or two. That point of view has been famously espoused by Arvind Subramanian of the Peterson Institute of International Economics and, for you trivia buffs out there, occasional co-author of Dr. Prasad. Anyway, I found the Prasad/Ye commentary in the current issue of IMF Finance & Development which we receive copies of here at the office. It's often an interesting, easy to read publication that keeps you up to date on things that are on the minds of IMF staffers.

First, let's begin with their recounting of the standard criteria (store of value, medium of exchange, unit of account) by which the functions of money are evaluated to see whether the RMB is indeed catching up with the US dollar:

The answer to that question depends on three related but distinct concepts about the currency:
•Internationalization: its use in denominating and settling cross-border trade and financial transactions—that is, as an international medium of exchange;

•Capital account convertibility: how much a country restricts inflows and outflows of financial capital—a fully open capital account has no restrictions; and

•Reserve currency: whether it is held by foreign central banks as protection against balance of payments crises.

The rest of their short contribution is well worth reading, but here's the concluding portion where they give the store away:

Is the renminbi on a trajectory to usurp the U.S. dollar’s role as the dominant global reserve currency? Perhaps, but the day is a long way off. It is more likely that, over the next decade, the renminbi will evolve into a reserve currency that erodes but doesn’t end the dollar’s dominance.
About two-thirds of global foreign exchange reserves are now held in U.S. dollar–denominated financial instruments. Other indicators, such as the dollar’s shares of foreign exchange market turnover and cross-border foreign currency liabilities of non-U.S. banks, confirm the currency’s dominance in global finance...

Moreover, a gulf remains between China and the United States when it comes to the availability of safe and liquid assets such as government bonds. The depth, breadth, and liquidity of U.S. financial markets are unmatched. Rather than catching up to the United States by building up debt, the challenge for China is to develop its other financial markets and increase the availability of high-quality renminbi-denominated assets.
The renminbi is attaining more prominence in international trade and finance. While this importance is sure to grow, the renminbi is unlikely to become a prominent reserve currency—let alone challenge the dollar’s dominance—unless it can be freely converted and China adopts an open capital account.

The challenge for the Chinese government is to back up its modest international policy actions with substantial domestic reforms. The renminbi’s prospects as a global currency will be shaped by a broader range of policies, especially those related to financial market development, exchange rate flexibility, and capital account liberalization. The path of China’s growth and the renminbi’s role in the global economy will depend on those policy choices.­

Actually, I do not trivialize what China needs to do to attain such a status. Nevertheless, I remain convinced that the RMB will inevitably become an important reserve currency in its own right--particularly in the Asia-Pacific as trade becomes more Sinocentric. However, surpassing the dollar outright will take more time, and even then I'm not entirely sure whether that's a pressing objective of Chinese leaders anyway. As I said, we're moving to a more multipolar world, and in such a world, there is no corresponding need to have an "alpha currency." There is no dollar-gold standard out there anymore, and there's little point in speculating that there will emerge an SDR-RMB standard or any suchlike.